The IRS issued standards that a limited liability company (LLC) must meet to be recognized as a 501(c)(3) tax-exempt organization in Notice 2021-56, released October 21, 2021.
An overview of the standards follows.
Tax-Exempt Determination Letter
The IRS will issue a favorable tax-exempt determination letter to an LLC with articles of incorporation and operating agreements that include the following:
- Provisions requiring that each member of the LLC be a 501(c)(3) tax-exempt organization, a government unit described in Section 170(c)(1), or a wholly owned instrumentality of a governmental unit
- Charitable purpose and charitable dissolution provisions that comply with existing regulations
- Chapter 42 compliance provisions, if the LLC is a private foundation. See details below.
- An acceptable contingency plan, such as suspending a member’s rights, if a member of the LLC ceases to be a 501(c)(3) organization or governmental unit
The LLC must represent in its tax-exempt application that all provisions in its articles of incorporation and operating agreement are consistent with applicable state law and legally enforceable.
Notice 2021-56 doesn’t affect the status of any LLCs currently recognized as section 501(c)(3) tax-exempt organization.
The Chapter 42 rules are described in Section 508(e)(1). The rules state that the governing documents of a private foundation must include provisions to require its annual income to be distributed so as not to subject the foundation to tax under Section 4942, as well as provisions to prohibit the foundation from engaging in self-dealing, having excess business holdings, making jeopardizing investments, or making taxable expenditures.
Background
Regulations surrounding exempt organizations were issued well before any states enacted the first LLC statute. As a result, the regulations don’t specifically address LLCs.
Historically, IRS standards applied in issuing determination letters to LLCs generally required LLC members be 501(c)(3) organizations, governmental units, or wholly owned instrumentalities of a state or political subdivision of a state.
Alignment with State Law
State laws that govern LLCs may differ from ones for not-for-profit entities. For example, in a few states, an LLC mustn’t be organized and operated exclusively for charitable purposes.
Many states have provisions that grant the LLC members economic rights that are inconsistent with section 501(c)(3). Other states don’t permit a statement of an LLC’s purpose in the articles of incorporation.
Under Notice 2021-56, when state law prohibits the addition of provisions to articles of incorporation, the LLC will meet the requirements if its operating agreement includes the required provisions and its articles of incorporation and operating agreement don’t have inconsistent provisions.
Request for Comments
The Treasury Department and IRS seek comments on the standards set out in the Notice, listing 11 particular areas, to determine if further guidance is needed.
Most of these 11 areas address questions regarding discrepancies with state LLC laws.
Written comments must be submitted by February 6, 2022, and should include a reference to Notice 2021-56.
Comments can be submitted two ways:
Internal Revenue Service
CC:PA:LPD:PR (Notice 2021-56)
Room 5203
PO Box 7604
Ben Franklin Station
Washington, DC 20044
We’re Here to Help
For more information about how Notice 2021-56 may affect your organization, contact your Moss Adams professional.
You can also learn more about our Not-for-Profit Practice and additional topics affecting the industry.